CH 6

AUDIT EVIDENCE

Chapter Objectives
1) Describe five evidence decisions made during the audit process. Explain the phrase "sufficient appropriate audit evidence." 2) List and explain the seven general methods of evidence collection. Explain the importance of automated audit techniques in supporting the conduct of recalculation and reperformance. 3) Discuss methods used to choose the types of evidence to collect. Describe the times when particular types of evidence collection are mandated. 4) Define analytical procedures. State their role in the evidence collection process. Discuss the purposes of five major types of analytical procedures.

Concept Check Answers C6-1 Page 171 How is audit evidence similar to legal evidence? There are well-defined procedures for the use of legal evidence. Auditors also have a well-defined process, linked to risk assessment, that is used in the evidence gathering process. Also, for both legal and audit purposes, evidence is used to support decisions. C6-2 Page 171 List the five evidence decisions that the auditor makes. Explain their relevance to the audit process. 1. Which risks, by assertion, could result in a RMM: This helps to target the evidence collection process. 2. Which audit procedure to use: Audit procedures are geared to particular audit objectives, considering costs and the nature of the client's systems. 3. What sample size to use: Sample size can be calculated statistically or using the professional judgment of the auditor, linked to the required assurance. 4. Which particular items to select: The auditor would describe the method used and the

relevance of the selection process (e.g., high dollar items). 5. When to perform the procedures: The nature of the test will affect timing (e.g. close to the year end, throughout the year, availability of data).

C6-3 Page 177 Provide one example of each of the seven methods of evidence collection. Inspection: Physically examine fixed assets and record their serial numbers. Observation: Watch employees punch a time clock when they arrive at work. Inquiry: Ask shipping clerk about procedures followed when receiving goods. Confirmation: Send a confirmation to the bank asking about bank balances and contingent liabilities Recalculation: Calculate the goods and services on an invoice. Reperformance: Trace the general ledger posting from the sales journal to the sales general ledger account. Analytical procedures: Calculate gross margin for each of the last five years. C6-4 Page 177 Why are CAATs important for recalculation and reporformance? CAATs enable the auditor to recalculate or reperform for a whole group of transactions cost-effectively (although they can also be used for a sample).

C6-5 Page 177 What is the difference between internal and external documentation? Internal documentation has never left the organization, while external documentation, even though it may have been prepared by the client organization, has left and been returned (such as a cheque that has been cleared by the bank). C6-6 Page 181 How does the quality of internal controls affect evidence? High quality internal controls may mean that there is less likelihood of error in the clients' records, while poor quality internal controls could mean the opposite. This will also affect the type of evidence to be collectedwith poor quality internal controls, the auditor will select substantive tests rather than tests of internal controls.

C6-7 Page 181 Describe 2 audit techniques that the auditor should use to reduce the risk of financial statement misstatement during the financial statement closing process. The types of evidence that should be collected are (i) a comparison of the underlying accounting records to the general ledger accounts with reconciliation to the
Auditing: The Art and Science of Assurance Engagements, C11e by Arens/Elder/Beasley/Splettstoesser-Hogeterp Copyright 2011 Pearson Canada Inc.

financial statements and (ii) a review of material adjustments or journal entries and their supporting documentation that are part of the financial statement preparation process

C6-8 Page 191 Why are analytical procedures an important part of the planning process? Analytical procedures are a tool to understand the client's business, to assess the entity's ability to continue as a going concern, and to indicate the presence of possible misstatements in the financial statements. These results help the auditor to target field work, possibly reducing tests of detail.

C6-9 Page 191 How can audit software assist the analytical review process? Audit software increases the scope of analytical review that can be conducted, as well as reducing its costs.

Chapter Summaries
1) What are the five evidence decisions that need to be made? After identifying the risk associated with audit objectives (1), the auditor needs to select audit procedures (2), choose sample size (3), decide on items to select (4), and determine the timing of the actual conduct of the procedures (5).

What does the auditor mean by the phrase "sufficient appropriate audit evidence"? The auditor needs to have enough evidence that is relevant to the financial statement accounts to state an opinion on the financial statements. 2) List and explain the seven general methods of evidence collection. These are inspection (physical examination of a tangible asset of document); observation (using senses, such as watching); inquiries of the client (obtaining written or oral details); confirmation (written or oral response from an independent third party); recalculation (computing mathematical items such as sales invoices and comparing to client results); reperformance (redoing internal control procedures); and analytical procedures (use of comparisons and relationships).

Why are automated audit procedures particularly helpful with recalculation and reperformance? Comparisons and calculations are often repeated for thousands of transactions. Having computer assisted audit procedures redo this work for all transactions rather than a sample helps to increase the effectiveness of audit procedures.

3) How does the auditor choose the type of evidence to collect? The auditor considers the independence of the provider, the effectiveness of internal controls, the qualifications of the provider (including the auditor), and the objectivity of the evidence in the context of the specific financial statement assertions that are being examined, as well as the overall risk of the engagement and the materiality of the account or balance. The auditor considers multiple sources so that consistency can be assessed among them.

Describe the times when particular types of evidence collection are mandated. The auditor needs to conduct control tests when substantive procedures are not sufficient, conduct tests of the financial statement closing process, and perform tests of detail when the risk of material misstatement for an account or transaction stream is high. 4) What are analytical procedures? They are the use of financial and non-financial data in meaningful comparisons and relationships to assess the reasonableness of account balances or other data. What is their role in the evidence collection process? They are used in all phases of the audit, and are required during the planning and completion phases. Describe five major types of analytical procedures. Client data can be compared with industry data, prior-period data, client-determined expected results, auditordetermined expected results, or non-financial data.

Evidence is considered appropriate when it is both relevant and reliable. What is meant by the terms relevant and reliable?

Audit evidence is relevant when it relates to the audit objective being tested. Reliability refers to whether a particular type of evidence can be relied upon to signal the true state of an assertion or audit objective.

Explain why, in most instances, audit evidence is persuasive rather than convincing.

Audit evidence is usually persuasive rather than convincing for two reasons. First, since an audit must be completed in a reasonable amount of time and at a reasonable cost, the auditor examines only a sample of the transactions that compose the class of transactions or account balance. Second, due to the nature of evidence, auditors must often rely on evidence that is not perfectly reliable. The types of audit evidence examined by the auditor have different degrees of reliability, and even highly reliable evidence has weaknesses. Therefore, the evidence obtained by the auditor seldom provides absolute assurance about an audit objective.

List and define the seven types of audit evidence.

The CICA Handbook specifies that audit evidence may be obtained through the methods of inspection, observation, inquiry, confirmation, recalculation, reperformance, and analytical procedures. These terms are defined and explained in CAS 500, from par. A7 (previously in Section 5300). Note that documentation is no longer considered a type of evidence collection method, but rather, it can be collected in different ways during evidence gathering. The seven types of audit evidence are:

(1) inspection involves the auditor inspecting or counting a tangible asset; (2) observation is the use of the senses to assess certain activities. Throughout the audit, there are many opportunities to exercise sight, hearing, touch, and smell to evaluate a wide range of things; (3) inquiry of the client is the obtaining of written or oral information from the client in response to questions from the auditor; (4) confirmation is the process of obtaining and evaluating a direct communication from a third party in response to a request for information about a particular item affecting financial statement assertions; (5) recalculation involves rechecking the computations and mathematical work completed by the client during the period under audit. (6) reperformance (or parallel simulation) is the redoing of other procedures such as internal controls (i.e., non-mathematical procedures); and (7) analytical procedures consists of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data.